Foreign Direct Investment(FDI)

def
• Investments from a parent firm to a location
outside a parent firms’ country of origin
• FDI is regarded by some people as a catalyst to
economic development but others view it as a
threat to economic development of host
country
• Is one of many other methods used to enter a
foreign markets
Other foreign market entry modes
• Licensing
• Franchising
• Consortia
• Technical Cooperation
• International Joint Ventures
• International Strategic Alliances
• Export: Direct & Indirect
 Classification of FDI
• Classified as either Vertical or Horizontal
Vertical FDI
• A geographical decentralisation of the firm’s
production chain
• Foreign affiliates are set up in a low wage and labour
intensive country and goods are shipped back to
parent company
• Also called ‘efficiency seeking FDI’
• Can also locate an affiliate company in a host country
due to attraction by unique competence of that
country eg India attracted IT firms from developed
countries due to its IT competency-technology
seeking FDI
 Horizontal FDI
• An affiliate company is set up in a foreign country
to service the local market-market seeking FDI
• Idea is to be close to customers, reduce transport
costs, avoid customs duty payment
FDI could also be Greenfield or Acquisitions
Greenfield- establish a new production unit
whereas an acquisition involves purchasing an
already existing foreign company
 Determinants of FDI
• Inflation
• infrastructural facilities,
• exchange rates,
• stable political environment,
• favourable interest rates,
• labour costs and
• Favourable corporate tax policy
• Property rights.
• Government commitment
 Determinants cont.
• Size and growth of the economy and prospects
• Natural and human resource endowments – cost
and productivity of labour
• Physical, financial and technological
infrastructure
• Openness to international trade and access to
international markets
• Development of the regulatory framework and
economic policy coherence
 FDI benefits/no benefits
• Empirical evidence on the relationship between
FDI and economic growth is still inconclusive
NEGATIVE EFFECTS
Based on the Dependency theory
Dependency theorists argue that
• Benefits of FDI is poorly distributed
• Foreign firms create distortions within the local
economy-squeeze of our local entrepreneurs,
alter consumer tastes, undermine local culture,
use inappropriate capital intensive technology
that leads to unemployment
 FDI disadvantages cont.
• Extractive nature of FDI- exploitation of natural
resources
• TNCs have superior technology & exploit
economies of scale & have access to large
financial resources to outcompete local firms-
crowding out
• TNCs have a tendency to source inputs from
their own international production networks-
leads to negative trade balance effects-pure
profits to them
• TNCs use their influence to pressurise host
governments
 FDI Benefits
• Capital flows-increase of GDP
• Technology spillovers-through demonstrations,
labour migration, linkages with buyers &
suppliers, imitation
• Increase in productivity
• Development of domestic firms-foreign firms
create additional demand for domestic
products
• Capital accumulation in local economy
• Positive effects on saving & investment
• Management skills
 FDI benefits cont.
• Structural effects
(a)Horizontal linkages-creates competition-leads
to efficiency in resource allocation-competition
leads to dynamic & innovative firms,
competition also leads to low product prices &
quality
(b) Vertical linkages-collaborative relations with
local firms
• Trade effects- increase in production boosts
exports